Good Evening: Investors waiting for the information to help them decide whether this week’s equity rally is genuine or not received good news on multiple fronts today. First, the economic statistics released today were either as expected or better than had been expected. Second, Bank of America became the third major bank in as many days to declare that it has been “profitable” during the opening months of 2009. Third, GE was downgraded merely one notch by S&P, to AA+ from AAA, much to the relief of investors in the company’s various securities. Finally, both bonds and commodities rallied together, an odd coupling that meant all the major asset classes went up in value today. Before we all break out the sunglasses to peer into what many suddenly perceive as a bright future, however, we should consider the deeds of a villain from our recent past.
In falling only 0.1%, retail sales figures for February came in much better than economists had been predicting. The ex-auto sales figures were even more surprising, rising 0.7% last month. Given the large upward revision to the January data, it was hard to claim this report was anything but strong. Jobless claims remained elevated, but at least they weren’t worse than had been feared. Equity investors took note of these data points, lifting our stock index futures out of the red prior to this morning’s opening bell.
Shortly after a lackluster open, stocks popped when Bank of America CEO, Ken Lewis, announced that, just like his competitors at Citigroup and JP Morgan, his bank also sports a profitable bottom line two months into Q1. Mr. Lewis expects this trend to continue all year (see below). Investors seized upon the news as further evidence that all the gloom surrounding bank shares has been unwarranted, but they failed to notice the footnotes. As with Vikram Pandit and Jamie Dimon before him, Mr. Lewis offered his profit forecast before including such mundane items as taxes and write-downs. If the CEOs get their way, EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) will apparently be replaced as a standard measure of cash flow. Let’s now all unite behind “EBITDAW” — EBITDA before the Write-offs — as the best way to measure bank profitability. Why Mr. Pandit and Mr. Lewis felt the need to tap Uncle Sam for huge new cash infusions during this “profitable” period is unknown, since both were mum on the subject.
Already trotting ahead with gains north of 1%, the major averages received a further boost when S&P took out its ratings axe and gave GE merely a close shave instead of a feared beheading (see below). GE’s shares and bonds rallied on the news, since AA+ is a lot better than the A or worse ratings previously implied by the prices for GE debt. Served up in addition to the ratings change was a slice of humble pie for GE’s CEO, Jeff Immelt. Mr. Immelt had made the absurd promise earlier this year that GE would hold onto both its AAA rating and its dividend. As speculated here back in January, Mr. Immelt lost both bets.
With GE, BAC, and other financial stocks leading the way higher, the major averages rallied for the rest of the day. The S&P 500 sliced right through the technical resistance at 740 (the November lows) and went out on its high tick (up 4%). Lagging behind the pack was the Dow Transport index (+ 3.1%), while the Russell 2000 (+ 6.5%) galloped ahead. Treasurys also finished on the firm side, and a solid 30 year auction was given most of the credit. The dollar eased 0.25% today against a basket of competing currencies, but commodity prices acted like stocks and shot higher. Crude oil’s advance of more than 10% set the tone as the CRB index posted an S&P-like gain of 4%.
I always welcome the comments and viewpoints of others, and, in the interest of equal time, let’s briefly take a look at Alan Greenspan’s written defense of the Fed’s behavior during the late, great housing bubble (see below). In crafting this piece for the Op Ed page of the Wall Street Journal, the Maestro acknowledges the growing chorus of discontent with the flow of easy money while he was at the helm of the Fed. Mr. Greenspan tries his best to lay out the case that it was a surplus of savings from abroad (read: Asia) that led to low interest rates for fixed rate mortgages, not Fed policy. The ankle-high fed funds rate had nothing to do with creating the housing bubble, according to the former Fed chief. Really.
Constant readers are probably already trying to click the delete key, since they know well my views about Mr. Greenspan. At the risk of picking too hard at the scab of repetition, let me offer a few observations of the Maestro’s defense of himself, er, the Fed. In preview, let me say that, in attempting to fire back at his critics, Mr. Greenspan actually shoots himself in the foot.
1) How could the term “Housing Bubble” be included in the title of your Op Ed, Mr. Greenspan? While in office you repeatedly stated that bubbles of all types were impossible to identify and that residential real estate in particular was unsuited to bubble-like investment behavior. That you now admit there was a housing bubble at all is an indictment of your previous claims.
2) Fixed rate mortgages were not the problem, sir. It was adjustable rate mortgages and their low teaser rates tied to the bottom-scraping funds rate that encouraged many to reach beyond their means for homes. ARM loans — the ones you advised folks to sign up for back in 2004 — are leading the way among mortgages that are currently either delinquent or in default.
3) The worst performing of these ARMs, Mr. Greenspan, have been Negative Amortization Option ARMS, a product that allows a mortgage holder to pick their own payment. This time-bomb-like option of deferring even principle payments came courtesy of the financial engineers on Wall Street. You publicly and repeatedly encouraged this form of creativity while in office. Similarly, your cheerful backing of CDOs and other structured products in support of the American Dream has also proved to be monumentally costly for all of us.
4) Your hidden shame, the nasty role in the housing bubble only a precious few have correctly fingered you for, was letting mortgage lending standards drop through the floor. As overseer of the banking system, the Fed has always had the power to regulate lending standards. It holds considerable sway with investment banks and even non-banks, too. Low Doc, No Doc, Liar’s loans — even fraud — were all allowed to take root, flourish, and push the value of homes ever higher on your watch. If someone could sign their name, they could buy a house. From 2003 until you left office, Mr. Greenspan, no American could either watch T.V. or pick up the daily mail without being assaulted for adds encouraging people to use and abuse these new mortgage products. You could have told the banks and others on Wall Street to cease and desist at any time. And yet you stood mute.
The interest rates you cite in your defense played only a bit part in this still-unfolding drama; the damage wrought by non existent lending standards have become the star of this horror show. Rather than make the hard choices while in office, you simply retired and handed to Mr. Bernanke both your keys and an impossible set of circumstances. The trail of tears you’ve left behind has brought both our banking system and the global economy to their knees. Thanks to you, bank CEOs now feel a need to trumpet their rising EBITDAWs. Shame on you, Mr. Greenspan, and shame to anyone who believes what you wrote in yesterday’s Wall Street Journal.
— Jack McHugh
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The Fed Didn’t Cause the Housing Bubble
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